ABSTRACT
This chapter aims to develop and estimates empirical models which examine the effects of exchange rate volatility on international trade flows. Many economists have expressed concern that this rise in exchange rate volatility has reduced the allocational efficiency of the international monetary system. The overall effect of exchange rate volatility on trade volume depends on firms attitude towards risk. The empirical analysis uses a multi-country dataset of Japan's bilateral industry-specific trade flows with its seven major trading partners together with other fundamental economic data on activity, costs, prices and exchange rates which feature in the theoretical framework. There is evidence of heteroscedasticity in the equation for Japan's imports from France, while all equations except for Japan's imports from Germany easily pass the Chow test for structural constancy. If volatility in exchange rates reflects shifts in underlying fundamentals, the cost of maintaining stability may be intervention in the market by the monetary authority.
